MIFID II: The Journey Continues

This marks the first instalment and introduction to perceiving MIFID II as we are about to enter the six month period towards the compliance date of 3 January 2018. In the lead up we intend to explore each impact area and share some perspectives on the non-EU implications for industry by way of obligations and prohibitions, market structures, and also tools and technologies.

  Let’s face it MIFID II hasn’t had the best start; being a sequel to an arguably ineffective prequel MIFID I that was focussed on a relatively small cash equities market, and being phased after a mammoth overhaul of the OTC market promoted by Dodd-Frank and later EMIR for Europe; MIFID II comes at a time where there is very little energy or impetus to focus for change. At this time, MIFID II will attempt to claim a large stake; the creation of new types open of trading venues, prompting further central clearing obligations for OTC trading, introduction of provisions on clients classification, product governance and distribution, the very concept and management of research, price formation and pre-trade transparency on a market-wide basis, sharpness of trade execution, management of commodity limits, and post-trade transparency to the public as well as extensions on trade reporting to the national regulators. Whilst industry participants in Europe are currently working on solutions having complete the majority of scoping, the impact outside of Europe is still being deciphered. This challenge is ultimately determined by organisation and stakeholders’ appetite to probe into the various levels of impact that can be expected.

 Belt & Braces

  There are certain dealings, which even though firms may be based outside of Europe, will be relevant. This will be referred to as a direct impact. An example is trading stocks that are listed in Europe, which also includes dual listed shares such as HSBC, or Standard Chartered. Trading of these stocks on trading venues will be subject to a host of transparency requirements dependent on the type of trading venue. If you deal with EU-based clients, depending on the type of client, and the level of investor protection they are afforded by MIFID II, an entirely MIFID II compliant entity will need to be established in Europe. This diversion of handling EU clients from non-EU entities should not be too difficult to arrange for truly global banks. That said, it is capturing information on who is dealing with who, and how profitable and convenient these relationships are, which will need to be looked at. If non-EU clients are to be have dealings with any EU entity, they will need Legal Entity Identifiers for the purpose of trade reporting. These are examples of direct impacts of MIFID II outside of the EU that result in non-EU entities interacting with EU instruments and/or entities. They may be few and far between, however they demand a thorough and traceable analysis that will draw on interviews, trade populations, and client analysis that will unearth essentially any in-scope footprint.

Feeling the Draft

  Whilst organisations may have carefully crafted booking models that avert many of the direct impacts through ring-fencing and handling EU clients with EU entities only, investor protection for EU investors means that a certain standard is being laid irrespective of who they deal with, including Asian counterparts. For example, the requirement to separate trade execution costs from research costs, and effectively unbundling these from the traditional package of investment services; this would be required by EU entities, however any party receiving services from Europe will need to pay for it, separate to execution costs. Therefore, they may choose not to receive any research, reducing payment to the EU entities. Or they may pass on research costs to end clients. Envision how EU entities will need to conform to pre-trade transparency requirements publishing price formation data to the market; this could be consumed by Asian parties, and used for gaining more favourable quotes. This will potentially stand EU players in Asian markets in better steed. Managing such indirect impacts, will also require some analysis, qualitative and quantitatively. Failure to do so, could lead to a lack of understanding on Day 1 on how to digest the suddenly available data, and therefore potentially different market dynamics that will be on show and then likely evolve over time. Sale and Trading may like to project different scenarios and resultant focus areas. This is particularly true for the non-Equities space where many of the changes may, or may not provoke change. A number of large banks are positioning themselves to take advantage of these changes. The largest area for indirect impacts outside of the EU is research. Research has been subjected to a number of changes provoked by predominantly provisions to guard against insider trading, and more recently to help ensure more independence in the trading process.

  Probe & Explore

 It won’t take much vetting to determine an organisations positioning over the changes that MIFID II looks set to bring; these will take time, far beyond Day 1 in January 2018. There has been a lot of regulation in overlapping spaces in financial services globally, and therefore MIFID II intending to have more macro impact than some of the more focussed regulation, will need time to stabilise and find lay its tentacles into the global financial markets. The more thought and discussion that can be dedicated to footprint, activity and positioning, the better firms will fare as the next steps unfold approaching January 2018 and beyond. Market participants are in often very different positions over the topics despite their close proximity and even seemingly similar dealings. MIFID II tracks back to origins and inherted profile, and therefore talking to peers and observers will be helpful in helping to shape outlooks and ideas.